Monetary Economics

Part A. Multiple Choice Questions (2 marks each, 40 marks in total)

  1. A trader buys 500 shares of a stock on margin at $36 a share using an initial leverage ratio of
    1.66. The maintenance margin requirement for the position is 30 percent. The stock price at which the margin call will occur is closest to:

A. $20.57
B. $25.20
C. $30.8

  1. Which of the following financial intermediaries are most likely to provide liquidity service to their clients?

A. Dealers
B. Brokers
C. Exchanges

  1. A trader places a limit order to buy shares at a price of $49.94 with the stock trading at a market bid price of $49.49 and the bid-ask spread of 0.7%. The order will most likely be filled at:

A. $49.49
B. $49.84
C. $49.94

  1. After the public announcement of the merger of two firms an investor makes abnormal returns by going long on the target firm and short on the acquiring firm. This most likely violates which form of market efficiency?

A. Semi-strong form only
B. Weak and semi-strong forms
C. Semi-strong and strong forms

  1. An analyst gathers the following information about two companies in the same industry:
    Company A Company B
    Book value per share $20 $10
    Market price per share $22 $13
    Return on equity 16% 13%
    Retention ratio 40% 60%
    What is the most appropriate conclusion regarding investors’ expectations? Compared to
    Company B, Company A has:

A. higher intrinsic value as reflected by its higher market price.
B. higher sustainable growth as reflected by its higher return on equity.
C. lower future investment opportunities due to its lower price-to-book ratio.

  1. An investor gathers the following data about a company:
    Most recent year’s dividend per share $1.47
    Next year’s estimate of earnings per share $4.00
    Estimate of long-run return on equity (ROE) 15%
    Estimate of long-run dividend payout ratio 40%
    Investors’ required rate of return 12%
    The company’s justified forward P/E is closest to:

A. 10.0
B. 13.3
C. 20.0

  1. Investor A’s marginal tax rate is 45%, while Investor B’s is 30%. Both investors are considering two bonds for inclusion in a taxable portfolio. One bond is tax-exempt with a yield of 4.50%, while the other is taxable with a yield of 6.30%. Which bond will each investor most likely choose?

A. Both investors will choose the taxable bond.
B. Both investors will choose the tax-exempt bond.
C. Investor A will choose the tax-exempt bond and Investor B will choose the taxable bond.

  1. Consider a 5-year option-free bond that is priced at a discount to par value. Assuming the discount rate does not change, one year from now the value of the bond will most likely:

A. increase.
B. decrease.
C. stay the same.

  1. The market value of an 18-year zero-coupon bond with a maturity value of $1,000 discounted at a 12% annual interest rate with semi-annual compounding is closest to:

A. $122.74.
B. $130.04.
C. $192.86.

  1. Assume the following six-month forward rates (presented on an annualized, bond-equivalent basis) were calculated from the yield curve.

Notation Forward Rate
1f0 0.50%
1f1 0.70%
1f2 1.00%
1f3 1.50%
1f4 2.20%
1f5 3.00%
1f6 4.00%

The 3-year spot rate is closest to:

A. 0.74%
B. 1.48%
C. 2.06%

  1. An asset management firm generated the following annual returns in their U.S. large cap equity portfolio:
    Year Net Return (%)
    2008 -34.8
    2009 32.2
    2010 11.1
    2011 -1.4

The 2012 return needed to achieve a trailing five year geometric mean annualized return of
5.0% when calculated at the end of 2012 is closest to:

A. 17.9%
B. 27.6%
C. 35.2%

  1. An asset has an annual return of 19.9%, standard deviation of returns of 18.5%, and correlation with the market of 0.9.
    If the standard deviation of returns on the market is15.9% and the risk-free rate is 1%, the beta of
    this asset is closest to:

A. 1.02
B. 1.05
C. 1.16

  1. A fixed exchange rate regime

A. forces a country to give up free international flows of capital.
B. forces a country to abandon independent monetary policy
C. can eliminate exchange rate uncertainty
D. is the model used by the U.S. Federal Reserve.

  1. If the exchange rate between the Australian dollar and the US dollar is expressed in direct quotation from an Australian perspective, then a rise in the exchange rate implies

A. appreciation of the US dollar.
B. depreciation of the US dollar.
C. appreciation of the Australian dollar.
D. B. and C.

  1. If the AUD/USD exchange rate declines from 1.2500 to 1.2430, then the fall is equal to

A. 70 points.
B. 7000 pips.
C. 700 points.
D. 70 pips.

  1. If a fixed exchange rate is set below the equilibrium rate in a fixed exchange rate system it will create

A. a deficit in the balance of payments.
B. a surplus in the balance of payments.
C. inflation.
D. deflation.

  1. Which of the following items is not a flow? A. Unilateral transfers.
    B. The increase in foreign assets held by Australian investors over a period of six months.
    C. Foreign exchange reserves lost by the Reserve Bank as a result of intervention in the foreign exchange market.
    D. The foreign currency and gold reserves of the Reserve Bank.

(Foreign currency and gold reserves are a STOCK).

  1. If the foreign currency equivalent of the domestic price of a commodity is less than the foreign price of the same commodity, then the LOP implies that

A. the foreign currency is overvalued.
B. the foreign currency is undervalued.
C. the domestic currency is overvalued.
D. none of the above.

  1. The $/DM exchange rate is DM1 = $0.35 and the DM/FF exchange rate is FF1 = DM0.31. What is the FF/$ exchange rate?

A. 3.226 French francs per dollar
B. 1.129 French francs per dollar
C. 0.886 French francs per dollar
D. 9.217 French francs per dollar
E. none of the above

  1. In a freely floating exchange rate system, if the capital account is running a deficit

A. the balance of payments must run a deficit
B. the balance of payments must be zero
C. the current account must run a surplus
D. b and c above
E. none of the above

Part B: Two (2) Short Answer questions. Marks are clearly stated in each question.
Answer all Two (2) questions in the answer booklet provided.
Question 1 (10 marks): What is the Bretton Woods system? And please briefly discuss reasons why this system eventually collapsed.

Question 2 (10 marks)
Assume the following information:
Current spot rate of British Pound =$1.60
1-year forward rate (as of today) for British Pound =$1.65
Expected spot rate one year from today=$1.67
Rate on 1-year deposits denominated in British Pound =2%
Rate on 1-year deposits denominated in A$ =4%
From the perspective of Australian investors with AUD1, 600 or GBP 1000, what is the rate of return yielded from the covered interest arbitrage??

Sample Solution